Do Institutional Investors Have an Ace up Their Sleeves? --Evidence from Confidential Filings of Portfolio Holdings1
Vikas Agarwal 2 Wei Jiang3 Yuehua Tang4 Baozhong Yang5
ABSTRACT This paper studies the holdings by institutional investors that are filed with a significant delay through amendments to Form 13F and that are not included in the standard 13F holdings databases (the “confidential holdings”). We find that asset management firms (hedge funds and investment companies/advisors) in general, and institutions that actively manage large and risky portfolios in particular, are more likely to seek confidentiality. The confidential holdings are disproportionately associated with information-sensitive events such as mergers and acquisitions, and include stocks subjected to greater information asymmetry. Moreover, the confidential holdings of asset management firms exhibit superior risk-adjusted performance up to four months after the quarter end, suggesting that these institutions may possess short-lived information. Our study highlights the tension between the regulators, public, and investment managers regarding the ownership disclosure, provides new evidence in the cross-sectional differences in the performance of institutional investors, and highlights the limitations of the standard 13F holdings databases. JEL Classification: G10, G19
1 The paper has benefited from comments and suggestions from Nicole Boyson, Jay Cai, Mark Chen, Conrad Ciccotello, Meyer “Mike” Eisenberg, Merritt Fox, Gerald Gay, Michael Gombola, Jeff Gordon, Laurie Hodrick, Lixin Huang, Narasimhan Jegadeesh, Jayant Kale, Omesh Kini, Chip Ryan, and seminar and conference participants at Columbia Business School, Columbia Law School, Georgia State University, University of Buffalo, All-Georgia Finance Conference, and the Conference on Financial Economics and Accounting at Rutgers Business School. We grateful acknowledge financial support from the Q Group. The authors thank George Connaughton, Bharat Kesavan, Vyacheslav Fos, and Linlin Ma for excellent research assistance. 2 J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1207, Atlanta, GA 30303. Research Fellow at the Centre for Financial Research (CFR), University of Cologne. Tel: 404 413 7326, Email: [email protected]. 3 Graduate School of Business, Columbia University, 3022 Broadway, Uris Hall 803, New York NY 10027. Tel: 212 854 9002, Email: [email protected]. 4 J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1221, Atlanta, GA 30303. Tel: 404 413 7313, Email: [email protected]. 5 J. Mack Robinson College of Business, Georgia State University, 35 Broad Street, Suite 1243, Atlanta, GA 30303. Tel: 404 413 7350, Email: [email protected]. Do Institutional Investors Have an Ace up Their Sleeves? --Evidence from Confidential Filings of Portfolio Holdings
This paper studies the holdings by institutional investors that are filed with a significant delay through amendments to Form 13F and that are not included in the standard 13F holdings databases (the “confidential holdings”). We find that asset management firms (hedge funds and investment companies/advisors) in general, and institutions that actively manage large and risky portfolios in particular, are more likely to seek confidentiality. The confidential holdings are disproportionately associated with information-sensitive events such as mergers and acquisitions, and include stocks subjected to greater information asymmetry. Moreover, the confidential holdings of asset management firms exhibit superior risk-adjusted performance up to four months after the quarter end, suggesting that these institutions may possess short-lived information. Our study highlights the tension between the regulators, public, and investment managers regarding the ownership disclosure, provides new evidence in the cross-sectional differences in the performance of institutional investors, and highlights the limitations of the standard 13F holdings databases.
Mandatory disclosure of ownership in public companies by investors is an essential part of the securities market regulation. At the core of this regulation is the Section 13(f) of the Securities Exchange Act of
1934 that requires institutional investment managers to disclose their quarterly portfolio holdings.6 The quarterly reports, filed to the Securities and Exchange Commission (SEC) on the Form 13F, disseminate the public information about holdings and investment activities of institutional investors. An exception to the rule, however, provides confidential treatment of certain holdings through amendments to the original
Form 13F. When adequate written factual support is provided for certain holdings, this provision allows the institutions to delay the disclosure of those holdings, usually up to one year. Throughout the paper, we refer to these amendments as “confidential filings,” and the positions included in such filings as
“confidential holdings.”
In this paper, we address two issues related to confidential holdings. First, we examine the motives for institutional investors to seek confidentiality. In particular, we investigate if the confidential holdings are information-driven by studying the institutional and stock characteristics associated with such holdings. Second, we estimate the abnormal performance of the confidential holdings, and analyze the cross-sectional variation in the performance of these holdings for different types of institutional
6 Section I.A. contains a more detailed description of the institutional background regarding the ownership disclosure.
1 investors.
Our study contributes to a large literature that studies the reported quarterly portfolio holdings of institutional investors to evaluate these investors’ performance and managerial ability, to extract information from the reported holdings to form investment strategies, or to relate institutional ownership to corporate policies and events. However, the prior papers use only the data on original 13F filings, usually from the Thomson Reuters Ownership Data (formerly the CDA/Spectrum database), and therefore ignore the confidential holdings because they are not included in the standard commercial databases.
Apart from minimizing price impact during ongoing acquisitions and dispositions, incentives to seek confidentiality most likely arise from private information as perceived by the investment manager. It is in the best interest of investment managers not to disclose their informed positions before they have reaped the full benefits of their superior information. Such incentives are often in conflict with the regulatory rules. For example, Perry Corp, a well-known hedge fund, attempted to keep secret its accumulation of position in Mylan Inc. in 2004 when the company was contemplating a merger with King
Pharmaceuticals Inc. The deal ultimately fell through; nevertheless, Perry was under investigation by the
SEC on the allegation of improperly withholding details about a large investment in an effort to profit. 7
Though the two parties settled in July 2009, the case highlights continuing tension between the desire of some investors to withhold information that could reveal their investment strategies, and the demand of the public and regulators for transparency.
As a matter of fact, several hedge funds and successful investors including Warren Buffett have appealed to the SEC for an exemption from revealing their positions in the 13F forms but have been unsuccessful in convincing the SEC. Philip Goldstein, an activist hedge fund manager at Bulldog
Investors likens his stock holdings to “trade secrets” as much as the protected formula used to make Coke, and contends that complying with the 13F rule “constitute[s] a ‘taking’ of [the fund’s] property without just compensation in violation of the Fifth Amendment to the Constitution.”8 In the wake of the “quant
7 For the SEC litigation release of this case, please see: http://www.sec.gov/litigation/admin/2009/34-60351.pdf. Perry was accused of violating the rule regarding Schedule 13D which requires prompt and proper disclosure of positions above 5%. 8 For a more detailed discussion, see Philip Goldstein’s interview in September 12, 2006 issue of Business Week:
2 meltdown” in August 2007, quant hedge funds blamed the ownership disclosure for inviting “copycats” into an increasingly correlated and crowded space of quant strategies, which contributed to the “death spiral” in the summer of 2007 when many funds employing similar strategies attempted to cut their risks simultaneously in response to their losses (Khandani and Lo (2007)). Most vocal among them was D. E.
Shaw & Company who demanded confidentiality for its whole portfolio in order to guard its proprietary models, but the request was denied by the SEC.
Though confidential treatment is meant to be the exception rather than the rule, some institutional investors seem to have taken advantage of it for the benefit of delayed disclosure. Our study is based on a comprehensive collection of all original and amendments to 13F filings by all institutions during the period of 1999-2007, where the amendments include both approved and rejected applications for confidential treatment. We find that 233 institutions (7.2% of all 13F filing institutions) have resorted to confidential treatment at least once, and the average (median) value of the confidential holdings amounts to 27.3% (12.3%) of the total value of securities included in both the original and confidential 13F holdings.
Analyzing the original and confidential holdings together uncovers several interesting results, which are consistent with the premise that institutions with informational advantages are more likely to seek confidentiality. Further, in terms of the types of stocks included in the confidential holdings, our findings are consistent with the motives regarding both withholding private information and minimizing price impact. Specifically, we document three main results. First, we find that hedge funds and investment companies/advisors are more likely to seek confidentiality compared to banks, insurance companies, and other institutions. Moreover, institutions resorting to confidential treatment tend to manage large and concentrated portfolios, and adopt non-standard investment strategies (in terms of low loadings on the common factors and high idiosyncratic risks). Prior literature (e.g., Kacperczyk, Sialm, and Zheng (2005),
Titman and Tiu (2009)) has shown that these characteristics are associated with more actively managed institutions that possess information and/or are skilled. Our results suggest that such institutions are more likely to seek confidentiality to benefit from their private information. Second, we observe that http://www.businessweek.com/print/investor/content/sep2006/pi20060913_356291.htm.
3 acquisition-related confidential holdings are more likely to consist of stocks associated with information- sensitive events such as mergers and acquisitions, and to include stocks subject to greater information asymmetry as measured by market capitalization, trading liquidity, analyst following, and probability of distress; while disposition-related confidential holdings are prominently characterized by relatively poor past return performance. Finally, acquisition-related confidential holdings of asset management firms
(hedge funds and investment companies/advisors) exhibit higher abnormal performance compared to their original holdings. However, this outperformance is short-lived (for a horizon up to four months) though economically significant. For example, as measured by value-weighted portfolio returns, the acquisition- based confidential holdings of asset management firms outperform their original holdings by 1.06% over a two-month horizon (6.36% on an annualized basis) after the quarter-end portfolio date.
Our study provides new evidence on the skill of asset-management firms and their ability to benefit from their private information through confidential holdings. It also has implications for researchers and regulators concerned with the transparency of financial institutions (especially the lightly- regulated hedge funds and private funds) and the role of mandatory disclosure of their investments. We believe that our study based on a complete collection of institutional investors’ quarterly holdings can help settle the controversy regarding the value and effect of the “non-transparent” holdings and identify the key factors that influence the cross sectional variation in the confidential filing activities. Finally, our study assesses the limitations of using the conventional institutional quarterly holdings databases that mostly exclude confidential holdings. While any error due to the omission in evaluating the aggregate portfolio performance of all institutions is likely to be small, there could be a significant bias in analyzing position changes of specific types of institutions or position changes around specific events (such as
M&A and block building).
Our paper is most closely related to the literature that evaluates the performance and information content of institutional investors’ holdings. For example, Grinblatt and Titman (1989, 1993), Grinblatt,
Titman, and Wermers (1995), Daniel, Grinblatt, Titman, and Wermers (1997), Chen, Jegadeesh, and
Wermers (2000), Wermers (2000, 2003, 2006), Kacperczyk, Sialm, and Zheng (2005, 2008), Wermers,
Yao, and Zhao (2007), and Huang and Kale (2009) analyze whether mutual funds outperform their
4 benchmarks using the holdings data. Griffin and Xu (2009) and Aragon and Martin (2009) conduct a similar analysis with another class of active managers—hedge funds. 9 By incorporating the confidential holdings and comparing them to the original holdings, our study provides a more complete picture of the ability and performance of a wide range of institutions.
Our paper also contributes to a strand of literature that studies the effects of portfolio disclosure on the investment decisions of money managers (Musto (1997, 1999)), theoretical implications of portfolio disclosure and performance evaluation of mutual funds (Kempf and Kreuzberg (2004)), the consequences of frequent portfolio disclosure such as free riding and front running by other market participants (Wermers (2001), and Frank, Poterba, Shackelford, and Shoven (2004)), and determinants of portfolio disclosure and its effect on performance and flows (Ge and Zheng (2006)). The findings in our study suggest that seeking confidential treatment is one effective way for the investment managers to attenuate some of the concerns analyzed in these papers.
The remainder of the paper is organized as follows. Section I provides background information regarding the SEC ownership disclosure rules. Section II describes the construction of sample, presents the overview of original and confidential filings, and outlines the empirical motivations. Section III analyzes the determinants of confidential filings at the institution level and confidential holdings at the stock level. Section IV examines the difference between the abnormal returns of confidential holdings and those of original holdings, and investigates the cross-sectional variation in these differences across different types of institutional investors. Finally, Section V discusses policy implications before concluding.
I. Institutional Background
The current ownership disclosure rules mandated by the SEC consists of five overlapping parts:
Schedule 13D for large (above 5%) active shareholders, Schedule 13G for large passive shareholders;
Form 13F for general institutional holdings; Section 16 regarding ownership by insiders; and Form N-
9 Aragon and Martin (2009) is among the very few papers that use the original 13F filings directly, instead of the filings complied by Thomson Reuters. They examine a random sample of 300 hedge funds from the SEC EDGAR database, and do not account for confidential filings in the 13F amendments filed separately.
5 CSR for quarterly disclosure of holdings required for mutual funds.10
Among the five regimes, the Form 13F requirement covers by far the largest number of institutional investors: all institutions that have investment discretion over $100 million or more in
Section 13(f) securities (mostly publicly traded equity; but also include convertible bonds, and some options) are required to disclose their quarter-end holdings in these securities. We call the date when the
Form 13F is filed with the SEC the “filing date,” and the quarter-end date on which the portfolio is being disclosed the “quarter-end portfolio date.” According to the SEC rule, the maximum lag between the two dates is 45 calendar days. As an exception to the rule, the SEC allows for the confidential treatment of certain portfolio holdings of institutions for which they can file 13F amendments. The provision allows the institutions to delay the disclosure of their holdings up to one year from the date required for the original 13F form. This one-year period can be extended further if an instruction with additional factual support is filed 14 calendar days in advance of the expiration date.
SEC began to adopt the Section 13(f) rules in 1978, which mandate the Form 13F quarterly reports by investment managers and allow confidential treatment of filings as deemed appropriate by the commission. In the legislative history of Section 13(f), the Senate Committee on Banking, Housing, and
Urban Affairs pointed out that: "[t]he Committee believes that generally it is in the public interest to grant confidential treatment to an ongoing investment strategy of an investment manager. Disclosure of such strategy would impede competition and could cause increased volatility in the market place." 11
Authorized by Section 13(f)(3), SEC may grant confidential treatment as it deems necessary or appropriate in the public interest or for the protection of the investment manager and the investors whose assets are under management. In 1979, SEC clarified the procedural and substantive criteria that confidential requests must satisfy for them to be granted, in an effort to standardize such requests.12
10 The SEC adopted enhanced rules on mutual funds expense and portfolio disclosure in 2004, requiring registered management investment companies to file their complete portfolio holdings with the Commission on a quarterly basis, instead of on a semi-annual basis as previously mandated. 11 Report of Senate Comm. on Banking, Housing and Urban Affairs, S. Rep. No. 75, 94th Cong., 1st Sess. 87 (1975). 12 For SEC release, please see http://www.sec.gov/rules/final/34-15979.pdf.
6 Gaining confidential treatment is not meant to be a trivial task and is not guaranteed. 13 The applying institution must provide a sufficient factual basis and a statement on the grounds of the objection to public disclosure, including a detailed description of the manager’s investment strategy, e.g., risk arbitrage that warrants confidential treatment, along with supporting analysis. Furthermore, the evidence for confidential treatment will not be applied to an entire portfolio appearing on a 13F form, but rather on a position-by-position basis. Finally, such applications are subject to SEC approval. The time that SEC takes to review individual applications and make the decision varies, with the typical range being two to twelve months. If denied, the institution is obligated to file an amendment disclosing all the confidential positions immediately (within six business days from the date of denial).14
In 1998, the SEC tightened the rules and restricted the conditions for accepting the applications for confidentiality.15 The triggering event was the confusion over the 13F reporting of investor Warren
Buffett which caused a significant decline in the share price of Wells Fargo & Co. in August 1997. The
13F form did not show Berkshire Hathaway’s well-known 8% stake in the bank, only because it was reported in a confidential filing. But the misunderstanding in the market caused Wells Fargo’s stock price to drop by 5.8% in one hour after Buffett’s 13F filing.16 Our sample period (1999-2007) falls into the new regime when there are more stringent rules for 13F amendments as the applying institutions need to convince the SEC that revelation of these holdings can hurt their competitive position.
The extreme case of D. E. Shaw illustrates the tension arising from such a process. On August 14,
2007, D.E. Shaw & Company, one of the largest quant-oriented hedge fund managers, filed an entirely blank Form 13F for its second-quarter portfolio. That is, the fund manager was seeking from the SEC a confidential treatment of its entire portfolio, based on the argument that “copycat investors” were
13 The SEC official guideline for 13F amendments is available at: http://www.sec.gov/about/forms/form13f.pdf. Section “Instructions for Confidential Treatment Requests” details the requirements. 14 For example, see http://www.sec.gov/rules/other/34-52134.pdf for the rejection of the request from a hedge fund, Two Sigma. There are several other cases of rejections of confidential treatment requests including those by Warren Buffett: http://www.sec.gov/rules/other/34-50206.htm, http://www.sec.gov/rules/other/34-43142.htm, and http://www.sec.gov/litigation/admin/34-43909.htm. 15 See http://www.sec.gov/divisions/investment/guidance/13fpt2.htm for the letter issued by the SEC in June 1998 where they explain the specific requirements and conditions for granting confidentiality. 16 For a full story, please see “Large Investors Face Stiff Rules on SEC Filings,” by Paul Beckett, The Wall Street Journal, June 19, 1998.
7 mimicking its strategies. The SEC denied the request on October 19, forcing the firm to file an amended
June 30th Form 13F on October 29. That amended filing covered 3,991 positions valued at $79 billion.
Similar but less extreme requests from D. E. Shaw were rejected by the SEC before. 17 Other frequent users of confidential filings include hedge funds (e.g. Dolphin Asset, Stark Investments, and Magnetar
Financial) and investment bank trading desks (e.g. Lehman Brothers, Goldman Sachs & Co, and UBS).
It is worth noting that the confidential treatment under Section 13(f) does not over-ride other SEC ownership disclosure rules. For example, a beneficial owner of more than 5% of a company’s equity will need to file Schedule 13D or 13G, even if the position is under confidential treatment in the owner’s 13F filing. The same can be said about the holdings disclosure required for registered investment companies
(mostly mutual funds), which was changed from a semi-annual to a quarterly basis (at a 60-day delay) in
2004. Nevertheless, there are more than sporadic observations in our sample where the confidential position exceeds 5% (such as the Warren Buffett position in Wells Fargo) or where the filer is a mutual fund management company (such as T. Rowe Price or American Funds). In such cases, the confidential treatment may still afford the institutions effective delay if the 13F disclosure is the most binding compared to the normal delay allowed by the Schedule 13G (45 days from the year-end) or by the disclosure rules for mutual funds (semi-annual for most of our sample period).18
If investment managers choose to file 13F amendments for securities about which they think that they have superior private information, these holdings are likely to be more informative than the regularly-disclosed holdings. Despite their potential importance, confidential holdings are usually not included in the conventional databases of institutional quarterly holdings.19 For example, the manual for
Thomson Reuters Ownership Data (formerly the CDA/Spectrum database), available through WRDS,
17 See “SEC: D.E. Shaw Disclosure Request Part of Regular Process,” by Marietta Cauchi, Dow Jones Newswires, January 2005. 18 Obviously the confidential treatment has become essentially unnecessary for mutual funds after 2004. In fact, some mutual fund companies, such as the Capital Research and Management Company (the management company of American Funds), have requested the SEC to extend the confidential treatment to mutual fund quarterly holdings disclosure shortly after the rule change (but without success). In our sample, confidential holdings by mutual fund management companies after 2004 most likely belong to these institutions’ non-mutual fund assets. For this reason, confidential holdings cannot explain the “return gap” documented by Kacperczyk, Sialm, and Zheng (2008) after 2004. Moreover, because 13F holdings reflect the aggregated positions at the institution level, we cannot attribute confidential holdings in 13F filings of an institution to individual funds within. 19 The other potential exclusion by these databases concerns non-equity holdings, such as convertible bonds and options, see Aragon and Martin (2009) for a detailed description of this issue.
8 provides the following caveat about its S12 (for mutual funds) and S34 (for institutions) data: “The holdings in the S12 and S34 sets are rarely the entire equity holdings of the manager or fund. There are minimum size requirements and confidentiality qualifications.”
An example from the top 20 confidential filers illustrates the omission by the Thomson Reuters database. The chosen institution is Stark Onshore Management LLC (manager number 10375 in
Thomson Reuters). In Table I, we list all the institution’s confidential holdings during our sample period, and cross check with its holdings reported in Thomson Reuters. We observe that, except for one stock
(Rouse Co., CUSIP = 77927310), all the other 54 confidential holdings in the amendments are not included in the latter.
[Insert Table I here.]
Therefore, arguably the most interesting facet of portfolio disclosure has been this far ignored in the extant literature. Our study fills this gap in the literature. We examine the motives for seeking confidentiality — more specifically to determine if it is information-driven, and then to estimate the abnormal performance of the confidential holdings, and analyze the cross-sectional variation in the frequency of resorting to confidentiality and the performance of confidential holdings for different types of institutional investors.
II. Sample Overview and Empirical Motivation
A. Sample of Original and Amendments to 13F Filings
A key data component to this study is the original 13F filings and amendments to these filings by all institutions. As we mentioned in the previous section, the standard databases do not provide a complete collection of these filings. Hence, we retrieve directly both the original and amendment 13F filings dated between March 1999 and June 2007 from the SEC’s website (EDGAR). We start in 1999 since SEC began to require electronic filing of Form 13F through the EDGAR system in January 1999; we end the sample of filings in June 2007 to allow for a one-year period in ex post performance
9 evaluation. Our full sample period happens to fall into a uniform policy regime after the SEC tightened up the rules for approving confidential treatment in 1998 (see Section I for more information)
Despite the large variation in reporting style and format, we are able to process the complete holdings information for 91% of all the 13F filings using manual processing, combined with automated computer programs. The resulting list of filing institutions in our initial sample amounts to 3,315, including 86.1% of the institutions that report their original 13F filings to Thomson Reuters over the sample period, plus 174 more institutions that do not appear in the Thomson database at all. 20
Amendments to 13F filings contain two types of information: disclosure of an increase in a position that was previously filed in or a new holding that was previously excluded from the original filings. We define a confidential holding as one that was excluded from the original filing or the difference between the restated position and the originally filed position. Our results are qualitatively similar if we impose a threshold for the difference in the second component or simply exclude the second component. Based on these criteria, our initial sample consists of 1,958 confidential filings and 55,185 original 13F filings. As we discussed earlier, the amendment filings in our sample include applications both approved and denied by the SEC. By searching for key words on the first page of the amendments, we are able to separate amendments filed before or upon the expiration of approved confidential treatment and those filed in response to SEC denials. 21 Based on this algorithm, the SEC rejected about 16% of all the confidential treatment applications during our sample period.
Figure 1 plots the time series of both types of filings, as well as the number of approved confidential filings, at the quarterly frequency. While the number of original filings increased steadily over our sample period, the time series for the number of confidential filings was choppier but stays roughly in proportion to the first series. Moreover, the SEC’s approval rate has trended higher since
2005.
[Insert Figure 1 here.]
20 We restrict our sample of original filings to the processed 13F filings directly retrieved from the SEC, rather than all holdings reported to Thomson Reuters. The idea is to maintain symmetry and comparability between original and confidential filings as the latter mostly do not make their way to Thomson Reuters. 21 We search for the appearance of certain negative phrases on the front page to identify amendments filed in response to SEC denials of the confidential treatment such as “denied” and “no longer warranted”.
10 Table II summarizes the cross-sectional distribution of both types of filings. Panel A reports the delay in days between filings and their corresponding quarter-end portfolio dates. Over 86% of original filings are filed within 45 days of the end of quarter, conforming to the requirement by SEC.22 On the other hand, more than 93% of confidential filings are filed more than 45 days from the quarter-end portfolio date, justifying resorting to the amendments for delayed disclosure. Surprisingly, the distribution of the duration does not differ qualitatively between amendment filings that result from SEC approvals of confidential treatment and those from rejections (not tabulated). The lack of a difference has two implications: First, some institutions may file amendments before the approved term for confidential treatment expires (usually for a year) because the information on the confidential holdings has already become stale. Second, even denied applications effectively afford significant delays in disclosure of confidential holdings (the modal delay time is between six and twelve months).23
[Insert Table II here.]
In our later analysis, we exclude confidential holdings filed within 45 days of delay, as motives to conceal positions in these filings cannot be justified. We also filter out both types of filings with extremely long delays from their quarter-end portfolio dates: more than a 180-day delay for the original filings and more than a 1505-day (four years plus the 45 days allowed for the original 13F filings) delay for the confidential filings. We suspect that these observations are results of data recording errors or irregular circumstances. These three filters combined remove less than 1.3% of original filings and about
8.6% of confidential filings (see Table II Panel A). Our results are not sensitive to the particular numerical choices employed in these filters. Moreover, our study focuses on equity holdings for which security-level characteristics are readily available and risk-adjusted performance measures are well- defined.
22 Aragon and Martin (2009) also found significant proportions of delayed original 13F filings (i.e., beyond 45- days). There is no explicit SEC rule regarding the penalty of occasional lateness in 13F filing, and we do not find a significant number of institutions in our sample which were repeatedly late in their original 13F filings. 23 The long time it takes for the SEC to reject applications for confidential treatment that lack adequate factual support could potentially invite abuse, that is, some institutions without legitimate reasons may still resort to frequent applications for confidentiality just to enjoy the effective delay in disclosure. Our informal conservation with the SEC staff indicates that institutions which received repeated rejections could receive warnings from the SEC and will be subject to more timely review in future applications.
11 Our final sample consists of 54,154 original filings by 3,246 institutions, and 1,592 confidential filings by 233 institutions. Panel B of Table II summarizes the number of filings, number of institutions, the dollar value, and the number of stocks in this final sample. Conditional on an institution filing both an original and an amended 13F for its holdings at a given quarter end, the dollar value of the stock positions included in the confidential filings is significant: the average (median) value of securities in a confidential filing is 27.3% (12.3%) of the value of the complete portfolio of the institution. In other words, the typical institution tends to “mask” one-eighth to one-quarter of its portfolio from the regular disclosure when they have both types of filings in a given quarter. The weight of confidential holdings in total portfolios in terms of number of stocks is smaller, indicating that these holdings tend to be larger-than-usual positions. The average confidential holding represents 1.2% of all the shares outstanding by the issuer, as compared to the average position of 0.69% in the original holdings.
Finally, Panel C of Table II lists the ten institutions that were the most frequent confidential filers during our sample period, and the ten institutions that received the highest number of rejections from the
SEC for their confidentiality applications. Berkshire Hathaway is on both lists. D. E. Shaw and Caxton
Corporation (currently renamed “Caxton Associates”), two of the top ten hedge fund companies in the
U.S. as of 2007, have been rejected by the SEC for 100% of their applications during our sample period.24
B. Motivations for Empirical Analyses
Our study is the first to present the prevalence and distribution of confidential filings by institutions. It is natural to ask questions about the incentives and consequences of seeking confidential treatment.
First, we hypothesize on the institutional characteristics that are associated with their propensity to use confidential filings. Institutions that engage in active portfolio management should be the most
24 We followed these two institutions out of the sample period. Caxton ceased to seek confidential treatment after October 2005 when eight of its applications were rejected all at once. D. E. Shaw stopped confidential filing after its last one in our sample in June 2007 for about a year. It has filed three applications since June 2008 each of which covers 2-3 stocks only (while the number was in hundreds and thousands before). All the three applications received speedy reviews and were approved by the SEC. These two cases provide some evidence about the possible SEC actions against institutions suspicious of abusing of the rules for 13F amendment filings, consistent with the discussion in previous footnote.
12 likely applicants for confidential treatment if the incentive is to delay disclosing holdings that could reveal their trading strategies. The degree to which institutional investors collect and process information and their ability to benefit from such activities will vary. However, in general, hedge funds and investment advisors are more likely to engage in proprietary trading strategies, where private information is essential in delivering superior returns, compared to banks, insurance companies and financial arms of corporations. Beyond the broad categories, certain characteristics that are indicative of institutions’ active management strategies—such as portfolio concentration, turnover rate, and portfolio idiosyncratic risk— should also be associated with higher frequencies of confidential filings.
Our second strand of analysis examines the determinants of confidential holdings in terms of stock characteristics. If the primary motivation of seeking confidentiality is to preserve the value of private information, confidential holdings should demonstrate such features. First, confidential holdings should consist disproportionately of stocks that are involved in information-sensitive events. For example, an explicit case identified by the SEC where positions are allowed confidentiality is related to open risk arbitrage positions. Hence, we expect target companies in M&A transactions to appear in confidential holdings with higher than usual probabilities. A more general determinant for a stock to be incorporated in the confidential portfolios of institutions is the degree of information asymmetry. Greater information asymmetry provides more opportunities for profitable private information acquisition activities.25 This incentivizes the institutions to conceal the positions in such stocks through confidential filings. As a result, several proxies for firm-specific drivers of information asymmetry, such as firm size, distress risk, and analyst following, should be correlated with the probabilities that individual stocks are included in the confidential holdings. Another motive for seeking confidential treatment is to minimize the price impact during an ongoing acquisition or disposition. Thus, low trading liquidity should increase the probability of a stock being treated confidentially. Needless to say, information asymmetry and illiquidity are closely related.
25 In fact, some investors having private information can lead to greater information asymmetry. Since we do not examine the determinants of information asymmetry, we are not concerned about the direction of causality here.
13 Finally, the motives to seek confidential treatment have implications for the return performance of the confidential holdings. If some institutions resort to confidential treatment to hide their ongoing acquisitions/dispositions that were driven by private information, or to hide a position where superior information has yet to run its full course, then one would expect that the confidential holdings exhibit positive abnormal performance compared to the holdings disclosed in the corresponding original filings.
Furthermore, this relation should be more significant for asset management companies or institutions with active portfolio management strategies. On the other hand, if confidential treatment is sought to minimize price impact or to avoid front-running on unfinished transactions that are liquidity-driven, then the realized performance of the confidential holdings should be neutral.26 Lastly, if the motive of seeking confidential treatment is to make it more difficult for observers of 13F holdings (potential copycats) to reverse-engineer the trading strategy, then the confidential holdings could be a portion of the portfolio that is potentially informative of the trading strategy, rather than most predictive of future returns. As such, the confidential holdings do not necessarily enjoy superior performance relative to the disclosed part of the portfolio. Nevertheless, if such trading strategies are indeed based on superior private information, then the performance of the overall portfolios of these institutions should be higher.
III. Determinants of Confidential Filings and Confidential Holdings
This section discusses the determinants of confidential filings at the institutional level (using institution-quarter data) and confidential holdings at the stock level (using institution-quarter-holding data). Unless otherwise specified, we incorporate quarterly fixed effects and adjust standard errors for heteroskedasticity and clustering at the institution level.
A. Institutional Characteristics and Propensity of Confidential Filings
We resort to the following models to relate the characteristics of institutions to their propensity to
26 Such a result does not necessarily negate the benefits of confidential treatment to the institution. The institution might otherwise have to incur higher transaction costs or less favourable price impact in order to finish its acquisition/disposition. Such costs are not captured by returns imputed from changes in holdings which ignore transaction costs.
14 use confidential filings. The first is a probit model:
(0)(CFjq,,,>=βλε InstChar jq ++ q jq > 0), (1) and the second is tobit model:
()Latent CF* =++γλω InstChar , j,,,qjqqjq (2) * ()max(,0).Observed CFjq,,= CF jq
The dependent variable in (1), (CFj,q > 0), is the indicator variable for the existence of a confidential filing in the (j, q) institution-quarter. The dependent variable in (2) is the dollar value proportion of confidential holdings in the total portfolio (that include both confidential holdings and holdings disclosed in the original 13F filings) of the given institution-quarter. The regressors in both models include a vector of institutional characteristics variables (InstChar) and quarterly dummies to control for unspecified time effects.
Results are reported in Table III. In addition to the coefficients and their associated t-statistics, we also report the average partial effects (APE) to facilitate the interpretation of the economic magnitude.
For the probit model, the APE is defined as:
APE=∂ E()Pr( CFjq,,, > 0) / ∂ InstChar jq | InstChar jq ,λ q . (3)
Our estimates of the APE are the empirical analogue to the expression above: